The publication of the FY09 Q2 results from Bangalore revenue assurance provider Subex will generate a mixed reception amongst investors. As the press release points out, product revenues are well up year-on-year. Product revenues for Q2 were US$26M (Rs.1,127M), up 57% compared to the same quarter last year, and slightly up compared to Q1. Consolidated revenues were US$33M (Rs.1,421M) up from US$24M (Rs.1,030M) in FY08 Q2. However, the press release does not say much more. Looking at the figures, it is easy to understand why. As anticipated, revenues from services continue to decline. There has also been a further reduction in operating costs. EBITDA before exceptionals is relatively healthy at US$5M for the quarter. However, the growing cost of interest accounts for more than half of that figure, highlighting that Subex will have liquidity challenges if it does not sustain its success in winning orders and converting them into cash. The biggest dent to the numbers came through exceptional exchange losses of US$16M on Subex’s FCCBs. After exceptionals and tax, Subex’s loss for the quarter was US$17M (Rs.717M), taking the loss for the year so far to US$32M (Rs.1,373M).

Going back to the forecasts for FY09, we see that Subex is still on course for its revenue projection of US$125M, having generated US$66M in the year so far. Although the management cannot be held responsible for foreign exchange fluctuations, Subex would now need a dramatic helping hand from world markets if it is to meet its forecast of US$12M profit after tax. The bad news about exceptionals may lead the careless investor to miss one key point: Q2 profit before exceptionals and tax was still slightly under US$1M. After the last two quarters’ results, Subex’s management has each time promised that investors will see the benefits of reduced costs following successful completion of integration. They cannot say that a third time. Yet, if Subex has now cut costs back to the minimum, a profit before exceptionals and tax of US$1M per quarter is still well short of what would have been needed to deliver the forecast US$12M profit after tax for the year. Given that revenues have been solid so far this year, it does not appear that the underlying business is as profitable as it needs to be to return a US$12M profit after tax over US$125M sales. EBIT before exceptionals was only slightly over 10% in Q2, making the forecasted returns unattainable as soon as you add in the real cash costs of interest and tax. Just to improve the underlying performance of the business to the point where quarterly results are in line with the profitability promised in the annual targets, Subex would need to generate US$3M profit after tax each quarter. It now needs to do significantly more in the second half of the year if annual profit targets are to be met, ignoring exceptional items. To deliver profits in line with expectations, Subex will need to further reduce its cost base, and healthily beat its forecast for revenues. For example, if Subex could reduce its staff costs by a further 5%, and if it could grow quarterly revenues by another 3%, then Subex’s underlying profitability would be roughly in line with that needed to generate annual profits of US$12M over sales of US$134M. The question is whether Subex is reaching a point where cost-cutting and sales generation are reaching a limit. If it is, then the targets cannot be realized, and investors will have to get used to the idea that Subex may be a viable business, but will not be as profitable as hoped. If, on the other hand, further cost-cutting and sales can be realized, this may lead investors to grow impatient with a management team that is turning the business around a lot more slowly than they originally promised. Losses on exceptionals are just one of many headaches for Subex right now.

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